Boston Fed's new research: Rising oil prices can't kill US employment; the probability of stagflation drops significantly but may last longer

Boston Fed's latest research indicates that the U.S. economy's vulnerability to oil price shocks has "fundamentally changed," with the impact of oil price shocks of the same magnitude on employment decreasing from 1.8 percentage points in the 1970s to nearly zero. The probability of stagflation recurring has greatly diminished, but inflationary pressures are actually more difficult to dissipate, with the PCE price index still being pushed up by about 1.5 percentage points.
(Background summary: Powell Harvard seminar: Fed has the confidence to "ignore oil price shocks," refuting the recurrence of 1970s stagflation)
(Additional background: Fed releases April FOMC minutes: Rising inflation may force rates to stay frozen longer, with the possibility of restarting rate hikes not ruled out)

Table of Contents

Toggle

• Employment "Immunity" but increased inflation stickiness
• Morgan Stanley calls for no rate changes throughout the year, rate cuts in 2027
• Widespread hawkish tone at the first FOMC of Hua Xu

Key Highlights

• Boston Fed study: Impact of oil shocks of the same scale on employment has decreased from -1.8 percentage points in the 1970s to nearly zero, greatly reducing the chance of stagflation recurrence
• Longer-lasting inflation pressures: Oil shocks still raise the PCE by about 1.5 percentage points (vs. 2.2 percentage points in the 1970s), with weakened employment buffers making energy inflation more sticky
• Morgan Stanley expects the Fed to keep rates unchanged in 2026 (3.50-3.75%), with rate cuts of 25 basis points each in March and June 2027

Oil prices used to be the biggest bear for the U.S. economy. In the 1970s, a wave of oil crises could simultaneously blow up employment and prices, forcing the Fed to choose between recession and inflation. But the Boston Fed's report released on June 4, titled "Reassessing the U.S. Economy’s Vulnerability to Oil Shocks," tells us that era is over, though at a cost.

This research was prompted by the latest round of oil price shocks triggered by the Iran war. The report clearly states that the vulnerability of the U.S. economy has "fundamentally changed," and the Fed's policy focus should shift from "fear of recession" to "fighting inflation."

Employment "Immunity" but increased inflation stickiness

The core finding of the report is a set of comparative figures. In the 1970s and 1980s, a 33% oil price shock would drag down national employment growth by about 1.8 percentage points within a year, but this figure has now fallen to nearly zero.

There are two reasons: a significant increase in domestic U.S. crude oil production, along with overall improvements in energy efficiency. According to Axios, the research team found that under a similar scale of oil shocks today, Texas's relative employment growth rate could rise by about 1.7 percentage points, while Massachusetts's could decline by about 0.4 percentage points. The production bonuses in oil and gas-producing states partially offset the pressure on other states, leaving overall employment almost unchanged.

But on the flip side, inflation is harder to bring down. The same 33% shock previously raised the PCE price index by about 2.2 percentage points in the 1970s, but today it still adds about 1.5 percentage points.

Morgan Stanley calls for no rate hikes in 2026, rate cuts in 2027

Morgan Stanley characterizes this round of oil shocks as a "short-term supply disruption." The firm estimates Brent crude oil prices will average $110 in Q2, fall back to $100 in Q3, and further decline to $80 in 2027. The Strait of Hormuz exports are gradually recovering, expected to return to steady-state levels before October.

Based on this assessment, Morgan Stanley expects the Fed to keep rates steady at 3.50%-3.75% throughout 2026, with rate cuts of 25 basis points each in March and June 2027, initiating a gradual normalization. Oil prices are not a core driver for rate hikes; the threshold for rate increases has clearly risen, but the direction remains downward.

Morgan Stanley's logic is that oil prices will cool off on their own, but the market may not have the patience to wait for that to happen.

Kevin Warsh cuts rates at first Fed meeting?
Yes 2% · No 98%

View full market & trade on Polymarket

Widespread hawkish tone at the first FOMC of Hua Xu

The June 16-17 FOMC meeting will be the first chaired by new Chairman Kevin Warsh since taking office on May 22. The market predicts a 97.8% chance of rates remaining unchanged, with little doubt.

But staying on hold doesn't mean no signals. The April FOMC minutes already revealed a clear hawkish shift, with most officials leaning toward removing easing bias and emphasizing that if inflation remains above 2%, rate hikes are possible. Data from Kalshi shows traders assign a 63% probability of rate hikes before July 2027; on Polymarket, the chance of rate hikes within 2026 is about 35%.

Frequently Asked Questions

What impact does the Boston Fed study have on Fed policy?

The study indicates that the impact of oil shocks on employment has greatly diminished, and the Fed no longer needs to overly worry about energy prices triggering a recession. The policy focus should be on suppressing inflation. With oil still raising the PCE by about 1.5 percentage points, maintaining tightening or even raising rates is more justified.

Will the Fed raise rates in 2026?

The market expects a 97.8% chance of rates remaining steady (3.50-3.75%) at the June 16-17 FOMC; however, data from Kalshi shows a 63% chance of rate hikes before July 2027. Morgan Stanley believes rates will stay unchanged throughout 2026, with rate cuts starting in 2027.